3.2. Volume decisions vs rate decisions

Where and what do you cut? Each line item needs to be justified in terms of its continued usefulness or necessity. You can cut a category of expenses like travel, or cut out an entire activity. To help with choosing where to focus spending and reductions it is helpful to put cost savings into two buckets: volume and rate.

Volume decisions are choices of less or more activity. Taking travel expenses for example, you could issue an instruction to reduce the number of car hire bookings by 30%. With less car hire transactions, some of the underlying activities tied to travel (customer visits, site inspections, employee training) just won’t happen.

Volume choices are often more difficult than rate choices.

Rate decisions continue an activity but at a lower cost. The activity continues (hopefully) in the same manner, but the organization pays a lower cost. Continuing the travel example, you might negotiate a preferred corporate rate with a car hire company lowering the cost of each trip. Therefore, the volume of trips continues at a lower cost.

The more rate savings initiatives the better since the organization doesn't have to reduce activity. Often rate decisions become new corporate policies. For example, you may create a policy that any airline tickets must be purchased within 14 days of travel to secure the lowest fare.

For each department prescribe the rules for who authorises, who reviews, who approves expenditure. Identify and clamp down where controls are slack. Have rules for emergencies where key people are not available. The team also ensures that systems and processes are in place for the detailed reporting, governance, and performance management needed for world-class ZBB. From a cultural standpoint, a company needs to ensure the tone is set from the top.

Leadership should meet with departmental managers to ensure they understand the importance of ZBB and are fully bought into the process. Leadership should allay staff concerns that the process will be time-consuming, and compensation will be tied strictly to the budget.

Instead, managers should understand that they’ll have the opportunity to motivate and justify their activities and projects, rather than have targets dictated to them from the top

When private equity firm 3G Capital bought ketchup maker H.J. Heinz in 2013, they implemented an aggressive form of ZBB that required managers to lay off people off and reduced investment in brand building, marketing, customer research and product innovation. Over the next two years Heinz dismissed 7,000 employees, closed six factories, and limited copier use to 200 pages per employee per month.

In 2017 3G announced that Heinz was the most profitable food company in its industry. Then in late 2019 the company suddenly announced a fourth quarter operating loss of $12.6 billion and wrote down the value of its Kraft brand by $15.4 billion, sending the share price down by 30%.

Aggressive cost reduction and stagnating sales played a key role in Heinz’s decline. While 3G was asking managers to justify paper clip expenses, its competitors were investing resources into product innovation and anticipating rapidly evolving consumer food trends.

“To keep up with shifts in consumer demand for food, you have to innovate. And to innovate you can’t use ZBB,” a competitor said.